Description of Hedging. Explanation.

Definition Hedging. Description.

Hedging is the process of protecting a company against unwanted
risk. For example, a firm who owes money to an overseas corporation may want
to hedge against the risk that the exchange rate moves against them. They
could do this by taking out a future contract for foreign exchange. In other
words they agree to buy now at a fixed price in the future.

Some form of risk taking is inherent to any business activity
(if there were no risk, it is likely there would be no reward). Some forms
of risk are "natural" to a business, whose competitive advantage is to manage
the risk well, i.e. to minimize the costs of the risk, against the profit
it is likely to achieve. Other forms of risk are not wanted, but cannot, as
things stand, be avoided. Hedging consists of selling off the unwanted risk
to those who have the ability or desire to take it. Typical examples of risks
that are often hedged are: insurance risks, credit risks and foreign exchange
risks.